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Performance measurement and controlTransfer PricingDivisional PerformanceInternational Taxation

ACCA · Question 32 · Performance measurement and control

Section C - Constructed Response 2

AeroParts Multi is a cross-border multinational company.
Division A is located in Country X (Corporate tax rate: 30%). It manufactures a specialized aerospace component.
Division B is located in Country Y (Corporate tax rate: 15%). It assembles these components into finished engines.

Division A's costs for the component:

  • Variable cost: $400 per unit
  • Fixed cost: $150 per unit
  • External market price: $800 per unit

Division A has a maximum capacity of 10,000 units and currently sells 8,000 units to the external market.
Division B requires 3,000 units of this component. Division B currently buys them from an external supplier for $750 per unit.

Head Office wants Division A to supply Division B. Division A's manager refuses to sell for less than the external market price of $800. Division B's manager refuses to pay more than their current external price of $750.

Requirements:
(a) Calculate the minimum transfer price Division A should accept and the maximum transfer price Division B should pay. (6 marks)
(b) Based on your calculations in (a), advise whether a mutually acceptable transfer price exists, and calculate the optimal transfer price from the perspective of the Head Office to minimize global tax liabilities. (6 marks)
(c) Discuss the behavioral and motivational issues that arise when Head Office dictates a transfer price to autonomous divisional managers. (8 marks)

How to approach this question

Step 1: Determine spare capacity. Step 2: Calculate Min TP (VC + Opportunity Cost) and Max TP (External purchase price). Step 3: Compare Min and Max to see if a deal is possible. Step 4: Look at the tax rates—shift profit to the lower tax country by manipulating the TP. Step 5: Discuss the human element of taking away a manager's right to set their own prices.

Full Answer

This question integrates transfer pricing rules with international tax strategy and behavioral performance management. The general rule for minimum transfer price is Marginal Cost + Opportunity Cost. Because capacity is constrained, the opportunity cost kicks in partway through the order. Furthermore, multinationals use transfer pricing to shift profits to low-tax jurisdictions, but this often conflicts with the goal of fair performance evaluation for divisional managers.

Common mistakes

Assuming a single minimum transfer price for all 3,000 units, ignoring the fact that spare capacity only covers 2,000 units.
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